Chapter 8: Stock Valuation

Dividends

payments by a corporation to shareholders, made in either cash or stock

The next dividend payment by Top Knot, Inc., will be $2.10 per share. The dividends are anticipated to maintain a 5% growth rate forever. If the stock currently sells for $48.00 per share, what is the required return on r?

r = 2.10 / 48 + 0.05 =0.09375 or 9.375%

Over the Counter (OTC) Market

securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories

Preferred Stock

stock with dividend priority, normally with a fixed dividend rate, and sometimes without voting rights

Capital Gain Yield

the dividend growth rate, or the rate at which the value of an investment grows

Order Flow

the flow of customer orders to buy and sell securities

Proxy

the grant of authority by a shareholder to someone else to vote his or her shares

Inside Quotes

the highest bid quotes and the lowest ask quotes for a security

Primary Market

the market in which new securities are originally sold to investors

Secondary Market

the market in which previously issued securities are traded among investors

Suppose you are thinking of purchasing the stock of Moore Oil, Inc. and you expect it to pay a $2 dividend in one year and you believe that you can sell the stock for $14 in one year. If you require a return of 20% on investments of this risk, what is the maximum you would be willing to pay?

$13.34 P0 = $2 / (1 + 0.20)^1 + $14 / (1 + 0.20)^1 = 13.34 FV=2 =14 I/YR=20 =20 N=1 =1 PV=$1.667 =$11.67 1.667 + 11.67 = 13.34

GOOG is not currently paying dividends. You predict in 5 years from today, the company will pay a dividend for the first time and will be D1 = $0.50 per share. The dividend is expected to grow at 10% indefinitely. The required return on companies such as this one is 20%. What is the price of the stock today?

$2.41 P4 = D5 / (r - g) = $0.50 / (0.20 - 0.10) = $5.00 FV = 5 N = 4 I/YR = 20 PV = ? = $2.41

The Bank of Manitoba has just paid a dividend of $3 per share. The dividend grows at a steady rate of 8% per year. Based on this information, what would the dividend be in 5 yers?

$4.41 $3 (1 + 0.08)^5

East Coast Energy Company has a policy of paying $1 per share dividend every year. If this policy is continued indefinitely, what is the value of a share if the required return is 20%?

$5 D/r = $1/0.20 = $5

The next dividend for the Bank of Prince Edward Island will be D1 = $4.00 per share. Investors require a 16% return on companies such as BPEI. The bank's dividend increases by 6% every year. Based on the dividend growth model, what is the value of BPEI stock today? What is the value in 4 years?

$50.50 P0 = $4 / (0.16 - 0.06) = $40.00 40 (1 + 0.06)^4 = 50.50

Shares of common stock of the Samson Company offer an expected total return of 12%. The dividend is increasing at a constant 8% per year. The dividend yield must be ___?

0.12 = D1 / P0 + 0.08 yield = 4%

Staggering Election Effects

1. it is more difficult for a minority to elect a director since fewer directors are up for election 2. takeover attempts are less likely due to a split up of elections over years

Bettis Corp.'s stock price is $20 per share, and its expected year-end dividend is $2 a share. The stock's required return is 15% and the dividend is expected to grow at a constant rate forever. What is the expected price of the stock 7 years from now?

20 = 2 / 0.15-g g = 0.05 20(1=0.05)^7 = 28.14

The common stock of Eddie's Engines, Inc. sells for 25.71 a share. The stock is expected to pay 1.80 per share next month when the annual dividend is distributed. Eddie's has established a pattern of increasing its dividends by 4% annually and expects to continue doing so. What is the market rate of return r on this stock?

25.71 = 1.80 / r-0.04 r = 11%

Albright Motors is expected to pay a year-end dividend of $3 a share. The stock currently sells for $30 a share. The required (and expected) rate of return on the stock is 16%. If the dividend is expected to grow at a constant rate, g, what is g?

30 = 3 / (0.16 - g) 3 = 4.8 - 30g 1.8 = 30g g = 6%

Ford is expected to pay a year end dividend of $2 a share. The stock currently sells for $40 a share. If the dividend is expected to grow at a constant rate of 8%, what is the required and expected rate of return on the stock?

40 = 2 / (r - 0.08) 40r - 3.2 = 2 40r = 5.2 r = 13%

Yummy Bakery just paid an annual dividend of $2.20 a share and is expected to increase that amount by 2.2 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 14 percent at the time of your purchase? A. $19.47 B. $18.16 C. $20.20 D. $19.89 E. $18.83

A. $19.47

Global Logistics just announced it is increasing its annual dividend to $1.68 next year and establishing a policy whereby the dividend will increase by 3.25 percent annually thereafter. How much will one share of this stock be worth ten years from now if the required rate of return is 13.5 percent? A. $22.57 B. $21.68 C. $26.51 D. $27.02 E. $27.37

A. $22.57

Gee-Gee common stock returned a nifty 21.6 percent rate of return last year. The dividend amount was $.25 a share which equated to a dividend yield of 1.01 percent. What was the rate of price appreciation for the year? A. 20.59 percent B. 23.60 percent C. 21.38 percent D. 22.87 percent E. 21.52 percent

A. 20.59 percent

The stream of customer orders coming in to the NYSE trading floor is called the: A. Order flow. B. Bid-ask spread. C. Trading volume. D. Paper trail. E. Commission trail.

A. Order flow.

A securities market primarily composed of dealers who buy and sell for their own inventories is referred to which type of market? A. Over-the-counter. B. Regional. C. Private. D. Auction. E. Insider.

A. Over-the-counter.

Which one of the following is a type of equity security that has a fixed dividend and a priority status over other equity securities? A. Preferred stock. B. Senior bond. C. Common stock. D. Warrant. E. Debenture.

A. Preferred stock.

A share of Bombardier is preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return?

Annual dividend = 2.50(4) = 10 r = d/P0 = 10/50 = 0.2 = 20%

Galloway, Inc. has an odd dividend policy. The company just paid a dividend of $6 per share and has announced that it will increase the dividend by $1 per share for each of the next 4 years, and then never pay another dividend. How much are you willing to pay per share today to buy this stock if you require a 10 percent return? A. $32.60 B. $26.57 C. $27.08 D. $24.15 E. $33.33

B. $26.57

Currently, a firm has an EPS of $2.54 and a benchmark PE of 16.4. Earnings are expected to grow 3.8 percent annually. What is the estimated current stock price? A. $46.08 B. $41.66 C. $43.24 D. $48.09 E. $42.89

B. $41.66

J&J Foods wants to issue some 6.5 percent preferred stock that has a stated liquidating value of $100 a share. The company has determined that stocks with similar characteristics provide a return of 9.5 percent. What should the offer price be? A. $64.20 B. $68.42 C. $71.38 D. $62.60 E. $77.26

B. $68.42

Home Products common stock sells for $18.31 a share and has a market rate of return of 12.8 percent. The company just paid an annual dividend of $1.42 per share. What is the dividend growth rate? A. 4.29 percent B. 4.68 percent C. 5.27 percent D. 4.45 percent E. 5.01 percent

B. 4.68 percent

Chemical Mines has 5,000 shareholders and is preparing to elect two new board members. You do not own enough shares to personally control the elections but are determined to oust the current leadership. Likewise, no other single shareholder owns sufficient shares to personally control the outcome of the election. Which one of the following is the most likely outcome of this situation given that some shareholders are happy with the existing management? A. Arbitrated settlement where the arbitrator determines who will be elected to the board. B. Proxy fight for control of the board. C. Negotiated settlement where each side is granted control over one of the open seats. D. Protracted legal battle over control of the board of directors. E. Control of the board decided without your influence.

B. Proxy fight for control of the board.

You want to purchase some shares of JJ Farms stock but need a 14.5 percent rate of return to compensate for the perceived risk. What is the maximum you are willing to spend per share to buy this stock if the company pays a constant $1.25 annual dividend per share? Select one: A. $9.11 B. $9.26 C. $9.38 D. $8.62 E. $8.47

D. $8.62

Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect: A. An increase in all stock values. B. Dividend-paying stocks to increase in price while non-dividend paying stocks remain constant in value. C. Dividend-paying stocks to maintain a constant price while non-dividend paying stocks decrease in value. D. A decrease in all stock values. E. All stock values to remain constant.

D. A decrease in all stock values.

The two-stage dividend growth model evaluates the current price of a stock based on the assumption a stock will: A. Increase the dividend amount every other year. B. Pay a constant dividend for the first two quarters of each year and then increase the dividend the last two quarters of each year. C. Pay increasing dividends for a fixed period of time, cease paying dividends for a period of time, and then commence paying increasing dividends for an indefinite period of time. D. Grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely. E. Pay an increasing dividend for a period of time and then cease paying dividends altogether.

D. Grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely.

Jen owns 30 shares of stock in Delta Fashions and wants to win a seat on the board of directors. The firm has a total of 100 shares of stock outstanding. Each share receives one vote. Presently, the company is voting to elect three new directors. Which one of the following statements must be true given this information? A. If straight voting applies, Jen can control all of the open seats. B. If cumulative voting applies, Jen can control all of the open seats. C. If straight voting applies, Jen is assured a seat on the board. D. If cumulative voting applies, Jen is assured one seat on the board. E. Regardless of the voting procedure, Jen does not own enough shares to gain a seat on the board.

D. If cumulative voting applies, Jen is assured one seat on the board.

If Bell Canada just paid a dividend of $1.50 a share (i.e. D0=$1.50) and the dividend is expected to grow 5% a year for the next 3 years and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?

D1 = $1.5750 D2 = $1.6538 D3 = $1.7364 D4 = $1.9101 D5 = $2.1011 D1 = D0(1 + g1)

Crystal Glass recently paid $3.60 as an annual dividend. Future dividends are projected at $3.80, $4.10, and $4.25 over the next three years, respectively. Beginning four years from now, the dividend is expected to increase by 3.25 percent annually. What is one share of this stock worth to you today if you require a 12.5 percent rate of return on similar investments? A. $43.40 B. $46.50 C. $45.88 D. $45.12 E. $42.92

E. $42.92

A preferred stock sells for $54.45 a share and provides a return of 9.826 percent. What is the amount of the dividend per share? A. $5.25 B. $5.45 C. $5.60 D. $5.50 E. $5.35

E. $5.35

The Blue Marlin is owned by a group of five shareholders who all vote independently and who all want personal control over the firm. What is the minimum percentage of the outstanding shares one of these shareholders must own if he or she is to gain personal control over this firm given that the firm uses straight voting? A. 20 percent plus one vote B. 17 percent C. 25 percent plus one vote D. 51 percent E. 50 percent plus one vote

E. 50 percent plus one vote

Which one of the following best describes NASDAQ? A. Market where the DMM's are located at posts. B. Dealer price at which they will buy is listed as the asked price. C. Largest U.S. stock market in terms of dollar trading volume. D. Market with three physical trading floors. E. Computer network of securities dealers.

E. Computer network of securities dealers.

Designated Market Maker (DMM) [Specialists]

NYSE members who act as dealers in particular stocks

Floor Brokers

NYSE members who execute customer buy and sell orders

The Stopperside Wardrobe Co. just paid a dividend of $1.95 per share on its stock. The dividends are expected to grow at a constant rate of 6% per year indefinitely. Investors require a 11% return on The Stopperside Wardrobe Co. stock, what is the current price? What will the price be in 15 years?

P0 = (1.95[1+0.06])/(0.11-0.06) = 41.34 41.34(1+0.06)^15 = 99.07

Foxtrap Inc. is a mature manufacturing firm. The company just paid a 10.46 dividend, but management expects to reduce the payout by 4% per year indefinitely, if you require an 11.5% return on the firm's stock, what will you pay for a share today?

P0 = (10.46[1-0.04]) / (0.115-[-0.04]) = $64.78

Your sister in law, stockbroker at Invest Inc., is trying to sell you stock with a current market price of $25. The stock's last dividend was $2 and dividends are expected to increase at a constant growth rate of 10%. Your required return on this stock is 20%. Should you buy the stock?

P0 = (2[1+0.10])/(0.20-0.10) = 22.00 Since the stock is for sale at $25, it is overvalued by $3, don't buy it

A stock is expected to pay a $0.45 dividend at the end of the year. The dividend is expected to grow at a constant rate of 4% a year, and the stock's required rate of return is 11%. What is the expected price of the stock 10 years from today?

P0 = 0.45 / (0.11 - 0.04) = 6.4286 6.4286(1+0.04)^10 = 9.52

Suppose Big D, Inc just paid a dividend of $0.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the stock be selling for?

P0 = 0.50(1+0.20) / 0.15-0.02 =3.92

Find the stock price of Microsoft if the current dividend is $2 per share and dividends are expected to grow at a rate of 6% in the near future and the required return is 12%

P0 = 2(1+0.06) / 0.12-0.06 = 35.33

Stairway Corporation will pay a $3.04 per share dividend next year. The company pledges to increase its dividend by 3.8% per year indefinitely. If you require an 11% return on your investments, how much will you pay of the company's stock today?

P0 = 3.04 / (0.11 - 0.038) = 42.22

Codner Corporation stock currently sells for $64 per share. The market requires a 10% return on the firm's stock. If the company maintains a constant 4.5% growth rate in dividends, what was the most recent dividend per share paid on the stock?

P0 = 64 = D0(1+g)/(R-g) D0 = 64(0.1-0.045)/(1.045) D0 = 3.37

Suppose TB Pirates, Inc. is expected to pay a $2 dividend in one year. If the dividend is expected to grow at 5% per year and the required return is 20%, what is the price?

P0= 2/0.20-0.05 = 13.33

Present Value

The price of stock today is equal to the _______________________ of all the future dividends

Preemptive Right

a firm that wants to sell stock must first offer it to existing shareholders before offering it to the general public

DMMs Post

a fixed place on the exchange floor where the DMM operates

Straight Voting

a procedure in which a shareholder may cast all votes for each member of the board of directors

Cumulative Voting

a procedure in which a shareholder may cast all votes for one member of the board of directors

Dividend Yield

a stocks expected cash dividend by its current price

Electronic Communications Network (ECN)

a website that allows investors to trade directly with each other

Broker

an agent who arranges security transactions among investors

Dealer

an agent who buys and sells securities from inventory

Common Stock

equity without priority for dividends or in bankruptcy

Supplemental Liquidity Providers (SLPs)

investment firms that are active participants in stocks assigned to them

Member

owner of a trading license on the NYSE